Is Tempur Sealy International (NYSE:TPX) Using Too Much Debt?

By
Simply Wall St
Published
January 10, 2022
NYSE:TPX
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Tempur Sealy International, Inc. (NYSE:TPX) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Tempur Sealy International

What Is Tempur Sealy International's Net Debt?

As you can see below, at the end of September 2021, Tempur Sealy International had US$2.26b of debt, up from US$1.46b a year ago. Click the image for more detail. However, because it has a cash reserve of US$503.3m, its net debt is less, at about US$1.76b.

debt-equity-history-analysis
NYSE:TPX Debt to Equity History January 10th 2022

How Healthy Is Tempur Sealy International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tempur Sealy International had liabilities of US$1.16b due within 12 months and liabilities of US$2.94b due beyond that. On the other hand, it had cash of US$503.3m and US$510.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.08b.

While this might seem like a lot, it is not so bad since Tempur Sealy International has a market capitalization of US$8.63b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Tempur Sealy International's moderate net debt to EBITDA ratio ( being 1.9), indicates prudence when it comes to debt. And its strong interest cover of 13.4 times, makes us even more comfortable. Pleasingly, Tempur Sealy International is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 101% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Tempur Sealy International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Tempur Sealy International generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Tempur Sealy International's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Tempur Sealy International's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Tempur Sealy International .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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